Royal Dutch Shell CEO on the End of ‘Easy Oil’

Despite the run-up in oil prices over the past decade, some analysts predict trouble ahead for big oil. Commonly cited long-term challenges include the rise of national oil companies and the increasing expenses of production after the world’s most accessible reserves are used up. Jeroen Van der Veer, CEO of Royal Dutch Shell, says those two factors could wind up working at odds with one another, which would provide a future for oil firms. When faced with the challenge of extracting less accessible oil, many national oil companies will need to turn to international oil firms, which currently have more advanced production capacity.

Some of the biggest investors and lenders in commodities market at this point are big hedge funds. Clearly this sharpens short-term price swings. It also creates risk, particularly given that in the current credit environment one doesn’t really know if some fund is going to be forced to sell off energy holdings at short notice.  How big of a risk is this, and how do you address it?

The way, at least in our company, that we look at oil prices, is we look at the fundamentals. Are the tankers in the Middle East waiting to pick up oil? No, that’s not the case. Is there refinery capacity to make gasoline and other products? Yes, there’s enough capacity. Do we see tailbacks at the gasoline station? No, we don’t see it. So the fiscal flow is very normal. So you can say that while the oil price is now at $100 per barrel, the fiscal flow is still the same from when it was $60 per barrel. So the fundamental fiscal flow is probably not the reason for the present oil price.

Now what could be the case is that there is a perceived lack of spare capacity. If you look at other industries—take for instance chemicals—if the chemical [manufacturers] come close to maximum capacity, you usually see that the margins get better. And that may happen in the oil industry as well. So as long as the markets think that we are close to maximum capacity, you may see a high oil price, very much dictated by the psychology of the day—that of the spare capacity increases or decreases.

The role of the speculative money is not that clear. There’s a lot of talking about it. I think you said it pretty well—probably it amplifies the swings—but whether it is the basic driver is not that clear. You may have some very long-term speculation.

How do you interpret the recent financial market regulatory reform proposals from Hank Paulson and the U.S. Treasury Department? What sorts of reforms are you most keen on, and which worry you the most?

The world has reached a kind of complexity and interdependency where even if you believe in capitalism, capitalism cannot work without government frameworks. I’m not an expert on the subprime crisis, but something has gone wrong—I think we all agree on that. It would be very strange if there’s no need to change certain parameters of the framework.

[But] with all due respect to the subprime crisis, it doesn’t have a lot to do with the oil industry. Of course if you have slowing demand in the world because people are more pessimistic, it will affect our industry. But if you look at worldwide oil demand, we are convinced that demand this year will be higher than last year. Whatever happens in the United States, or even in Europe, we are convinced that the pull from China and India and other Middle Eastern and Far Eastern countries will outweigh that.

Well specifically, one of the proposals is to merge the SEC with the CFTC [Commodity Futures Trading Commission], which regulates how oil futures are traded. What do you think of that?

If we have an opinion, we will do that only after careful consideration. We won’t shoot from the hip.

Let’s talk more about demand. You mentioned you think global prices will continue to rise this year despite the rise in oil prices. How high do you think prices would have to get before you would see much more dramatic efforts to curtail demand than what we’ve seen thus far?

Worldwide, only ten years ago we were at oil prices around $10 per barrel, and the world thought we might have low oil prices for the very long term. In that world, it is harder to see how you can get off the ground renewables and other unconventional supplies. But at present oil prices, even if they go lower than today, you have quite an umbrella, as I call it, to get renewables or very difficult unconventional oils off the ground. But with all those forms of energy there are huge time delays. The frustration, particularly with politicians, they see a problem today and then they expect that something is onstream and implemented one year from now. Take for instance, outside the oil industry, if you want to build a new generation of nuclear power stations, you have the permits and the restrictions et cetera. Eventually you will have an impact, but then you are many years down the road. That’s the supply side.

On the demand side, we were a little surprised at Shell how low the elasticity is to demand. We think it may happen that people won’t drive less, but that next time they buy a car they will buy a more fuel efficient car. And secondly, if you look at the price of gasoline in Europe and taxation on gasoline, duties on gasoline, compared to the United States—and of course the gasoline price in Europe is comparable to seven or eight dollars a gallon, compared to your three—the fuel efficiency of European cars is about 40 percent better. So you see that higher prices will work over time.

Given restricted access to oil fields, and increasingly complicated and expensive oil-field geology, do you think there is a natural global production limit for oil in the short term?

Yes and no. Easy oil and easy gas—cheap-to-produce oil and cheap-to-produce gas, close to the markets where it is consumed—will peak one day, because it is simply depleted. If you look at the total of what Mother Nature has put in the ground, we have a very long way to go. But the problem is Mother Nature put it in places—very deep water, very far away, in the Arctic—that need huge investments in dollars-per-barrel, and new technologies—what I call brain-cells-per-barrel. That’s what it needs, and it will take huge time delays to get it onstream. So the reaction time has become a lot slower than with the easy oil. That’s where we are now.

When you look at estimates of global demand for oil over the next couple decades, do you think oil producers will ever produce that much oil, or do you think the world will just adjust to lower production?

You have to split out the easy oil. So what is the easy oil? We don’t know exactly but we wouldn’t be surprised if this oil would peak somewhere in the next ten years. Then there’s the unconventional oil. We’ve got the unconventional oil onstream. But what the total is, we are not that precise.

Over the past several decades, the percentage of the global oil market controlled by NOCs, or national oil companies, has increased substantially. Do you think that trend is likely to continue?

It will flatten out. So basically, international oil companies, they can get access to oil because they are better with technology, or better with project management, or better with operational excellence. So they bring something to the table that’s unique—otherwise the NOCs would do it themselves.

But realize that the easy oil depends of course which NOC you are—but that will peak for them as well. Not in Saudi Arabia, because there’s so much easy oil. But in other countries where you have good NOCs, they have less easy oil, and then they will need to go to unconventionals. And the technology is in the hands of the IOCs. So there you see why the percentage increase will flatten out, or maybe one day will even turn.

Why don’t NOCs reinvest more of their profits in future production capacity, or in these new technologies? Are there just no incentives there?

First of all, certain countries have philosophies about what they would like to [hold] for their children, how they spread it over the generations. They think, “This is long-term money under my feet.” Or there can be capacity problems or other political problems.

Having said that, if you look at Saudi Arabia, what they invest is really quite a lot. They do in fact do expansions. But the world is so hungry for additional energy that it can’t solve the whole problem. The Saudis, in a limited amount of time, will add about 2 million barrels per day, which is more than 2 percent of world oil demand. This is really sizeable.

How does the energy industry see the current U.S. presidential elections? What are your biggest hopes or biggest concerns?

[Laughs] No, you won’t get me there! I hope the people get the president they deserve.

In a year, are oil prices higher or lower?

We will never, as a matter of policy, give any forecast about oil prices. If we did that, probably you would have to take the opposite from what we say—if you look at internal price forecasts, usually we are wrong. Let me say how we do it at Shell. The whole company is prepared for three possibilities: high oil prices, low oil prices, and very volatile oil prices. Maybe that’s good advice for other people as well.